What is NCD?

Non-Convertible Debentures (NCDs) are fixed-income debt instruments with a defined maturity date and cannot be converted into equity or shares. They provide investors with regular interest payouts, which may be structured on monthly, quarterly, or annual schedules, depending on the option chosen at the time of investment. Compared to convertible debentures, NCDs carry lower risk, greater liquidity, and typically offer higher yields. Additionally, they provide certain tax benefits, making them an attractive investment choice for risk-averse investors.

Types of NCDs

NCDs are broadly classified into two types based on their repayment structure:

1. Secured NCDs

Secured NCDs are backed by the company’s assets, which act as collateral. In case of default, investors have a legal claim on these assets, making secured NCDs safer. Their key features include lower risk, predictable returns, and relatively higher investor confidence. However, due to reduced risk, their interest rates are often slightly lower than unsecured NCDs.

2. Unsecured NCDs

Unsecured NCDs are not backed by collateral. They rely solely on the issuer’s creditworthiness and repayment ability. As a result, they carry higher risk, but to compensate, they generally offer higher interest rates. Investors must carefully evaluate the issuer’s financial health before opting for unsecured NCDs, as defaults could result in greater losses.

What Are the Features of NCDs?

• High Rates of Interest

If kept till maturity, non-convertible debentures can provide high interest. The interest amount is paid out monthly, quarterly, semi-annually, or yearly. Non-convertible debentures also include a cumulative payment option.

• Taxation

NCDs have tax ramifications based on the investor's tax bracket. If NCDs are traded within a year of acquisition, short-term capital gain tax at the income tax bracket rate will be applied. If the NCDs are traded after a year of the acquisition or before the date of maturity, the gains qualify as long-term capital gains and are taxed at 12.5% without indexation for transfers made on or after July 23, 2024. The interest income of non-convertible debentures is tax-treated in the same way as fixed-income assets, under the head of 'income from other sources'.

• Credit Ranking

Credit evaluation organisations evaluate companies. The credit ranking of a firm is very important in determining its viability. A better credit rating indicates that the firm can meet its credit commitments. On the other hand, a poor credit ranking indicates that the firm faces significant credit concerns. If an issuing firm fails to complete payments, the rating organisations assign it a lower ranking.

Who Can Invest in NCDs?

NCDs are open to a wide variety of investors. Institutional investors include public financial institutions, statutory corporations, commercial banks, co-operative banks, regional rural banks, insurance companies, provident and pension funds, mutual funds, and other SEBI-registered funds.

On the non-institutional side are companies, bodies corporate, religious or charitable trusts, scientific or industrial research organisations, partnership firms, and limited liability partnerships.

Individual investors (resident Indians) and Hindu Undivided Families (HUFs) through their Karta are also eligible. Non-Resident Indians (NRIs) and Persons of Indian Origin can sometimes invest, subject to the issuing company’s terms and compliance with foreign exchange regulations.

How to Purchase NCDs?

To buy NCDs, you need a demat account and a trading account with a stockbroker, since most NCDs are issued and traded electronically.

You can purchase NCDs in two ways:

(a) through a primary issue, when the company offers new NCDs and you apply during the subscription period via your broker or bank using the ASBA facility; or

(b) through the secondary market, after the NCDs are listed on stock exchanges like NSE or BSE, where they are traded like shares.

Once allotted, the NCDs are credited directly to your demat account.

What Should You Consider Before Investing in NCDs?

• Debt Level

It is advisable to avoid investing in a non-convertible debenture if the firm's unsecured loans represent more than half of its overall asset value.

• Credit Ranking

Credit rankings assess a company's capacity to generate cash through internal and external activities, as well as its long-term viability. It is an ideal metric for determining a firm's financial situation.

• Non-Performing Asset Provisions

A corporation must hold a minimum of half of its overall assets for NPAs since it is a good measure of asset quality. It is recommended to not invest in a company that has poor debts.

• Interest Coverage Ratio

The ICR or Interest Coverage Ratio is a measure of a company's capacity to smoothly settle its loan interests at any particular moment.

• CAR

Capital Adequacy Ratio or CAR assesses the firm's capital and determines if it has enough money to withstand probable losses.

• Tax Bracket

Interest income from NCDs is taxed under the head “Income from Other Sources”, at the investor’s slab rate. So, if you are in a lower slab, you keep more of the interest.

Conclusion

Non-Convertible Debentures can be a valuable addition to your investment portfolio, especially if you are looking to diversify beyond traditional equity investments like stocks. They offer fixed returns, a defined maturity, and relatively lower risk compared to equity. However, like any financial instrument, they are not risk free. Before investing, it is important to carefully assess the issuer’s credibility, understand the tax implications, and evaluate whether the payout structure aligns with your financial goals and liquidity needs.